A Fiduciary Duty for All Investment Professionals?

Wading hip deep into the debate over the standard of conduct applicable to investment advisors, author Kristina A. Fausti brings helpful insight in A Fiduciary Duty for All?

Ms. Fausti is the Director of Legal and Regulatory Affairs for Fiduciary360, and is knowledgeable about the investment world.

What she demonstrates is that the investment world is not equally knowledgeable about fiduciary standards, even at the highest levels of the Securities and Exchange Commission, which shows bone-headed ignorance regarding fiduciary obligations.

Ms. Fausti shows her expertise when she notes that “Broker-dealers [ ] often have competing interests with their customers that they neither must avoid nor disclose in most cases. For example, as Professor Mercer Bullard noted, an investment adviser would be required under the fiduciary standard to disclose any differential compensation it receives as the result of recommending different products to its client because of the conflict of interest such differential compensation creates. Broker-dealers, however, generally have no such obligation to disclose differential compensation to their clients.”

Now that is what the fiduciary standard really means – full, complete, and candid disclosure. And that scares the heck out of Wall Street.

Ms. Fausti notes that “the Obama Administration’s plan called for legislators and regulators to ‘harmonize’ the investment adviser and broker-dealer regulatory regimes.” The investment community has thrived in the confusion of a post Glass-Steagall era. “The Administration’s recommendations were based on the widespread recognition that retail investors are often confused about the differences between investment advisers and broker-dealers.”

That statement is as right as rain. “The RAND Report issued by the SEC in January 2008 [ ] concluded that investors did not understand key distinctions between investment advisers and broker-dealers, including their duties, the titles they use, and the services they offer. Also contributing to investor confusion is the ambiguity and inconsistency in titles used across the financial services industry.”

What, then, is the delay in establishing such harmony? The desire of the financial services industry to maintain confusion. “In practice many financial professionals use varying titles to describe themselves including: financial advisor, financial consultant, advisor, financial planner, and stockbroker.”

Author Fausti sees the ball clearly. “In its most basic form, to act as a ‘fiduciary’ is to serve under an already defined standard based on a relationship of trust that carries with it duties of loyalty, due care, and utmost good faith.”

Yes, but don’t forget that those are aspects of the fiduciary obligation, in other words, the duties and consequences that flow from a finding that the parties occupy a fiduciary relationship.

Sadly, SEC Commissioner Luis A. Aguilar lacks similar clarity of thought, having “passionately emphasized” that “there is only one fiduciary standard and it means that a fiduciary has an affirmative obligation to put a client’s interests above his or her own.”

Wrong, wrong, wrong. That is simply sloppy thinking. By an SEC Commissioner.

In contrast, these guys get it right. Says the author, “A group of advisory and investor advocates, dubbed the Committee for the Fiduciary Standard, recently articulated a set of five core fiduciary principles: (1) put client’s interest first, (2) act with prudence, (3) do not mislead clients, (4) avoid conflicts of interest, and (5) fully disclose and fairly manage unavoidable conflicts.”

OK, now we are back on track. “What these principles illustrate is a basic relationship based on trust that demands that loyalty and due care always remain at the foundation of the fiduciary standard.”

SEC Commissioner Elisse B. Walter “has noted that what is required under the fiduciary duty depends on the scope of the engagement as well as the sophistication of the investor.”

Wrong again. If someone is in a fiduciary relationship, then the expertise or knowledge of the beneficiary matters not one whit. The beneficiary gets to put complete trust in his or her fiduciary, and never has to defend his own interests because he is a “big boy” (the so-called “big boy” defense).

It’s simply gobbly-gook for the investment community to claim differing duties “where a financial professional is a ‘dual hatter,’ [which] is meant to refer to a professional who is registered both as a broker-dealer and an investment adviser representative and who, therefore, switches professional hats for different services and products.”

According to Wall Street, “the professional would be a fiduciary and subject to Adviser Act and the fiduciary duty when providing investment advice, but subject to Exchange Act and FINRA rules when executing recommended transactions; thus, switching back and forth between acting as a fiduciary.”

That is just impossible. A mainstay of the fiduciary standard is the duty of care. The fiduciary looks out for his or her beneficiary, not the other way around. Wall Street’s proposal (which proposal is not backed by Ms. Fausti, may I add) is voodoo.

One standard for all financial advisers. One set of obligations, anchored in duties of care and disclosure. That’s not so hard. But it scares the hell out of Wall Street.

I disagree with your statement, “If someone is in a fiduciary relationship, then the expertise or knowledge of the beneficiary matters not one whit.”

A fiduciary who is properly managing its conflicts of interest must receive informed consent from the client. The knowledge and expertise of the client matters very much because gaining consent from a client who does not understand your disclosure is not an informed consent.

I also disagree with your criticism of Commissioner Aguilar’s statement about putting the client’s interests first…his phrasing is a simple initial litmus test that fiduciaries can use whenever they are recommending or taking a course of action. For you to use this example to claim Comm. Aguilar lacks clarity of thought is disingenuous.

I think we are going to have to disagree on this point. One of the underpinnings of fiduciary law is trust. Because of the relationship, the law permits the beneficiary to trust the fiduciary.

Is an agent held to a lower standard because his principal is skilled? No, the agent is required to discharge his or her duties faithfully and honestly. Same for lawyers. We are not subject to a lower standard because of the skill and knowledge of our clients. That is black letter law, expressed in such familiar treatises as the Restatement of Agency.

You are suggesting that the standard of performance is lower when the principal is an expert. Only if so agreed in an express contract. Otherwise, the duty of is not reduced merely because of the knowledge of the principal. The fiduciary principle states that the beneficiary gets to trust his fiduciary, not that the beneficiary has to scrutinize his fiduciary based on the principal’s expertise and knowledge.

I agree with everything you have stated except for the part where you thought I was suggesting that the standard can be lowered if the principal is an expert. No where did I suggest such a deviation from fiduciary principles. My point is that because one of the hallmarks of a fiduciary is to properly manage conflicts of interest, it does indeed matter whether or not the principal is capable of fully understanding a conflict as disclosed by the fiduciary. If he or she does not understand it, no informed consent to a conflict cannot be given.
Thus, for example, it is my opinion that a fiduciary cannot accept compensation such as commissions or other transaction-based compensation except in special circumstances and then only where this prima facie conflict is fully disclosed and consented to by a knowledgeable principal.